As the oft quoted Warren Buffet said, “
derivatives are dangerous.” Of course, the top American banks, now struggling for their financial lives – including JP Morgan Chase, the famed name behind the creation of the credit default swap back in 1997 – are now well aware of this, as they face the ticking time bomb potentials of massive losses in these shadowy, basically unregulated markets.
A number of these top banks share the distinctive feature of being deemed too big to fail by a government bent on funneling astounding amounts of taxpayer money into their coffers to create a semblance of solvency. Taxpayers are told this is essential to reviving the economy, yet one has to wonder… Is there a
tipping point in the balance, perhaps when the derivative losses see the light of day, when it will just take too much bailout money to prop these banks up for another day? When the whole Ponzi-esque scam will just come tumbling down, taking the
hollowed-out, broken shell of the American, perhaps even the global, economy with it?
I suppose it all seemed like a good idea at the time, back in 1997 when a crack team of financial wizards at JP Morgan Chase devised a way to shift and spread the potential fiscal repercussions of default that are inherent in any loan, whether a
bad credit loan to a person with a challenged credit history or loans to well-established businesses with a long record of credit-worthiness. The credit default swap is among the most well known and most popular of the credit derivative financial products available, a class of financial instruments that has grown into a veritable alphabet soup of products and a market involving trillions of dollars.
There are some, however, that say that the financial wizards didn’t care if it was a good ideal or not, just as long as it was able to shift risk and increase profit potentials. It seems that monetizing debt has become the American way. It is said to be a means of keeping liquidity in the market, defended as a way to ensure the availability of credit, something that we are all told is essential to continued economic growth. Yet, it could be debated that what we have seen is not economic growth, but rather a mushrooming of debt fueling a false sense that lifestyles have improved, as those improvements are not really real wealth, as it is all just debt.
In other words, while more Americans own homes and many have more things – cars, electronics, furnishings, etc. and so on – they don’t really own them, as their acquisition of those things came through the taking on of debt, such as mortgages, home equity loans, credit cards,
personal loans, and the like. Much of this debt has been sold and leveraged multiple times, making its way into the derivatives market as investment instruments and other financial vehicles.
According to an article published on
March 9, 2009, in McClatchy Newspapers, “five of America's largest banks, most of which have received $145 billion in taxpayer bailout dollars, still face potentially catastrophic losses from exotic investments,” such as some of those exciting investment opportunities found in the derivatives market. These 5 banks, said the article, “account for more than 95 percent of U.S. banks' trading in this array of complex derivatives” and, as we all know, 4 of the 5 have had their reserves “augmented by taxpayer bailout money, topped by Citibank — $50 billion — and Bank of America — $45 billion, plus a $100 billion loan guarantee.”
These banks, which include JP Morgan Chase, Citibank, Bank of America, Wells Fargo, and HSCB Bank USA, as reported in the McClatchy story, which cited data from the banks’ fourth quarter financial reports from 2008, “said that their net current risks and potential future losses from derivatives surpass $1.2 trillion. The potential near-term losses of $587 billion easily exceed the banks' combined $497 billion in so-called "risk-based capital," the assets they hold in reserve for disaster scenarios.”
As many who have been following the financial news of late already know, devastating as the derivatives market loss potential that these banks face is, the banks are not the only players in this high-risk game. Investors throughout the globe have money at risk. Pension funds, state and local governments, investment funds, and a host of others have significant financial involvement in the derivatives market. Many have seen their retirement plans shattered and are coming to the realization that they are simply going to, despite their financial planning, have to work until they drop and pray that ill health doesn’t interfere with their ability to hold a job.
How is it that a market with such destructive potentials was able to spring up and expand with virtually no regulation when so many other aspects of finance are regulated? The answer – an ongoing and serious problem with legislation today, the passing of bills with thousands of pages that are voted upon without ever even being read by those doing the voting. They may get highlights from staffers, but actually read the bills cover to cover themselves? No. They don’t. There ought to be a law that forces them to read and understand what they are voting on, but there isn’t.
Commodity Futures Modernization Act of 2000 is the legislation we can thank for the lack of regulation in this market, coincidently the same bit of legislation that made the whole Enron debacle possible. The bill was hurried through as a companion bill to a major government spending bill made up of about 11,000 pages and voted upon on the final day before the holiday break that year. There were no hearings and it became law on December 21, 2000 – another success for financial industry lobbyists.
According to
Chuck Burr, in a February 2009 article, “total world derivatives are $1000 trillion or 19 times the total world GDP of $54 trillion. Over-the-counter derivatives total $684 trillion of which 67 percent are interest rate swaps. Exchange-traded derivatives total $344 trillion.” While it is difficult to attach value to the more volatile products of the derivative markets, and estimates do vary significantly, most do agree that derivative totals are well above the global GDP.
Warren Buffet also referred to derivatives as financial weapons of mass destruction. With losses in the derivative markets mounting, and those losses touching multiple points in the economy, it does seem as though the derivatives market certainly does have the power
to threaten the fundamental viability not just of the economy of the United States, but also that of the entire world. Hang on to your hats, folks, ‘cause it looks like the unwinding of this mess is gonna be a wild ride indeed.
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